ESG investing, focusing on Environmental, Social, and Governance factors, has moved from a niche strategy to a central theme in global capital markets. While the momentum is strong, the path forward is complex, with both opportunities and challenges shaping investor decisions in 2025.
#Environmental: The Push for Clean Energy
The environmental component of ESG investing has gained prominence, particularly with global initiatives like the Paris Agreement aiming to limit global warming. Renewable energy sources such as wind, solar, and hydro are at the forefront of this transition.
However, the shift isn't without hurdles. For instance, Europe's aging power grid infrastructure and inadequate energy storage pose serious threats to electricity reliability, as highlighted by recent blackouts in Spain and Portugal. The European Commission estimates up to $2.3 trillion will be needed by 2050 to upgrade the grid and prevent such incidents.
In the U.S., clean energy investments have faced setbacks. The Trump administration's rollback of clean energy initiatives led to significant economic repercussions, with approximately 20,000 clean energy jobs lost since the November election and an additional 40,000 at risk due to paused or threatened projects. For more information read our guide to investing in cleantech.
#The Environmental Aspect of ESG
When looking at the environmental part of ESG, it is important to put this in the context of the world events that are impacting this area. Events such as COP and the signing of the Kyoto Protocol have undoubtedly had a huge sway on how businesses conduct themselves, affecting their credibility as companies worth investing in.
Notably, COP21 in Paris in 2015 brought about the Paris Agreement, aiming to limit global warming to well below 2, preferably to 1.5 degrees Celsius, compared to pre-industrial levels.
Renewable energy is seen as a key solution to climate action. Electric vehicles (EVs), in particular, have gained traction, with companies like Tesla leading the charge. Traditional carmakers are catching up, and while some EV startups have faltered, others have seen their share prices rise.
Electricity generation from renewable sources like hydrogen, wind, solar, hydro, tidal, geothermal, and biomass, along with carbon capture initiatives, offers routes to reducing our carbon footprint. Nuclear energy, while not renewable, is another potentially environmentally friendly solution. However, no single energy source can solve the world's problems alone.
Investors have opportunities in publicly-listed companies involved in these areas of environmental progress.
The Decline of Oil, Gas & Coal
The coal industry's demise was easily justified, and replacing it with cleaner alternatives is not too arduous an undertaking. However, it is still heavily relied upon in emerging markets, particularly China, and phasing it out entirely is expensive.
Oil and gas, on the other hand, are not so easily displaced.
In recent years, financial institutions have boycotted these industries as investment in ESG-friendly alternatives gained precedence. While well-meaning sentiment can drive narratives, the fundamentals are left to speak for themselves.
Reducing the carbon economy before the green economy is ready to roll seems a relatively foolish endeavor, leading down the dangerous path to much higher energy prices. If production declines to the point that supplies are limited, and demand continues to increase, then prices will rise. If energy prices are high, company costs spiral out of control, and what was once a profitable business can quickly become unviable as inflation eats into profit margins.
Meanwhile, the economy suffers if people can't afford to keep the lights on, put food on their tables, and fuel in their cars.
Carbon Credits
Every business has a carbon footprint. To reduce their footprint more quickly, they can buy carbon credits to finance projects that reduce or absorb carbon emissions around the world. This provides a way for less ESG-friendly companies to offset their carbon emissions.
Tesla is producing electric vehicles and is therefore considered environmentally friendly. It makes a lot of money from selling carbon credits to traditional automakers that are not yet on a green path. This may seem like a cheat, but it is a legal cheat, and the carbon credit business is likely to get much, much bigger.
#The Social Aspect of ESG
Socially responsible investing (SRI) has evolved, with investors becoming more selective about where to put their cash. Avoiding "sin stocks" like gambling, weapons, and tobacco has expanded to include companies that look after their employees, protect the environment, and behave as upstanding citizens.
One pitfall of SRI is the belief that these investments lack profit potential, but this view is changing. Companies prioritizing social factors often see long-term benefits, such as better employee retention and customer satisfaction.
Investors are increasingly wary of companies with governance issues. For instance, firms lacking board diversity or with opaque financial disclosures often face higher risks and lower valuations.
Regulatory bodies are also tightening governance standards, requiring more comprehensive reporting and adherence to ethical guidelines.
#G stands for Governance
Effective corporate governance is vital in steering a company in a positive direction. It identifies who has power and accountability and who makes decisions. Good governance incorporates managerial responsibility, board structure, and shareholder rights.
Corporate governance is something every company should consider. Whether public, private, big, or small, the way a company is governed speaks volumes to its success.
#The Bull Case: Aligning Values and Returns
ESG investing is here to stay, driven by an altruistic desire for the common good. Companies embracing the circular economy are meeting consumer desires to improve and thus enhancing their attractiveness as investments.
Aligning profits with principles is an honorable quest. Technology is paving the way for innovative startups in areas like lab-grown meat, vertical farming, and aquaculture, which could revolutionize the food industry and address global hunger with less pollution.
Fast fashion could be replaced with sustainable alternatives and environmentally friendly fabrics made from agricultural by-products. Fashion swap sites and clothing rental businesses have also increased.
Construction is being shaken up with innovative ways to produce environmentally friendly concrete.
#The Bear Case: Practical Challenges
Despite the desire to transition to renewables and terminate investments in fossil fuels, the reality is complex. Modern living standards rely on oil and gas. Construction, a significant global polluter, remains heavily reliant on coal to turn iron ore into steel.
Electricity generation often requires natural gas, which, while cleaner than coal, still produces greenhouse gases. Demand for these commodities is increasing, especially in countries like Africa, India, and China, which are transitioning to higher living standards requiring massive construction projects and fossil fuel use.
Energy Poverty
Energy consumption and global warming are linked. Sadly, the countries likely to suffer most from the devastating effects of climate change are those that have done the least to cause it.
“Some people have wasted energy, but others haven’t had anything to waste.”
- Jimmy Carter Energy and the National Goals - A Crisis of Confidence delivered 15 July, 1979
Modernizing the power grid requires massive storage capacity, ultra-high voltage, and numerous components, all requiring natural resources. Transitioning to a carbon-free existence may involve temporary blackouts and high energy prices. Trial and error combined with unprecedented spending appear to be the way forward. Nevertheless, some products and services are emerging, indicating progress toward a carbon-neutral future.
ESG investing is reshaping the financial landscape, offering a way to pursue returns while promoting sustainability and ethical practices. However, investors must navigate a complex terrain of evolving standards, regulatory changes, and practical challenges. Staying informed and critically assessing ESG factors is essential for making sound investment choices in this dynamic environment.